FACTORS DETERMINING ADEQUACY OF CAPITAL IN COMMERCIAL BANKS*

Abstract

THE FIRST THREE CHAPTERS of this thesis discuss capitalization in the perspective of the search for safety over the period of history of banking in the United States, the philosophy of the supervisory focus on capital based in depression experience, and the negligible effect of supervision on allocation of assets and capital. Analysis of the real factors influencing the quantity and quality of capital is similar to a study in econometrics with size, growth, and profitability as the independent variables and capitalization as the dependent variable on the first level. Independent variables on the first level become dependent variables on the second level with other independent variables influencing them. Quantitative and qualitative influences exist on both levels of analysis. Capitalization is a function of size and growth factors which vary in their influence according to growth conditions and policies affecting structure (Chapter IV). Profitability is also a function of size and growth. Although profitability fluctuates in the short run with given levels of capitalization, in the long run levels of capitalization adjust to achieve competitive rates of return regardless of differences in size and growth. The principle that secular changes in capitalization occur through changes in capital rather than through changes in deposits and assets is established by multiple correlation analysis for banks in the United States for the period 1953-62 (Chapter V). On the second level of analysis, two sets of independent variables influence size, growth, and profitability. One set includes local influences. A comparative case study of five commercial banks illustrates that, within size groups, variations in capitalization are associated with local and regional economic conditions, competitive conditions among banks and between banks and savings and loan associations, and philosophy of management in the individual bank. The local variables other than economic conditions are not weighted or designated as causes or effects since there is mutual interaction. The alternative choices of management in seeking to maximize profit are limited by bank history, existing competitive arrangements, and local economic conditions. The levels of capitalization which result are not the free choice of management (Chapter VI). The most pervasive set of independent variables on the second level of analysis includes the nature of the economy, the environment provided by government, and the nature of the banking system. Changes in public policies are causes and effects of this set of variables. Independent changes in the set induce changes in public policy, and vice versa. Historically the issues of policy portrayed a parallelism which no longer exists. The parallel issues included tight (sound) money versus easy (unsound) money, concentration of financial power (federal power) versus decentralization of financial power (states' rights), and safety versus competition. The disappearance of a strict parallelism is the result of the development of a nationwide interdependent economy and the transfer of political and economic power from the